Tuesday, 13 December 2016

Reactionary Keynesianism

Under Donald Trump
we might get what some have called Reactionary Keynesianism. But a
stimulus is a stimulus, right, and for those of us who think most
OECD economies should be ‘run hot’ to try and make up some of the
ground still lost from the Great Recession any fiscal stimulus should
be welcomed? So Martin Sandbu writes

“it is hypocritical of anyone to warn that Trump’s promised tax
cuts will endanger the public finances if they called for fiscal
stimulus under Obama and his putative Democratic successor. ….
While the composition of tax cuts and spending increases may matter,
the overall size of any deficit increase matters at least as much.”

If by this he means don’t worry too much about the composition, the
overall size of the deficit is more important, I think this is
terrible macroeconomics. It is foolish to believe that anything that
raises the deficit will stimulate.

We know that a part of any Trump stimulus will be large tax breaks
for the very rich. The very rich will almost certainly consume
virtually none of this tax break in the short term. It is the one
part of the population where Ricardian Equivalence almost holds. You
might think that therefore it does at least do no harm to short term
aggregate demand. But this could be wrong, because the logic of the
intertemporal budget constraint still operates. Those tax cuts will
not be paid for by higher activity in the short term, so they may
mean higher taxes down the road. Now if people who are not very rich
think that these might be their taxes that are increased down the
road, they will reduce their consumption today. The net effect could
be a drop in demand.

You may think that consumers may not be so foresighted, so demand
will not actually fall. But the logic of the intertemporal budget
constraint still holds. If tax cuts for the rich just raise the
deficit with almost no short run demand boost, then that is a
transfer to the rich today from the non-rich tomorrow. If tax cuts
for the rich were paid for by tax increases on everyone else today
many politicians would be up in arms. Delaying the tax increase on
everyone else by borrowing is a trick that should be seen straight
through.

Yet I fear this is still not the case, and talking about tax cuts for
the rich as part of a stimulus just helps confuse politicians. Those
on the right understand this: tax cuts for the rich are nearly always
part of a general stimulus: when Nigel Lawson did this it helped bust
the UK economy. We should just repeat again and again: tax cuts for
the rich paid for by borrowing are really tax increases for everyone
else.

The example of tax cuts for the rich is the example that refutes the
general proposition that the composition of any fiscal stimulus
matters less than the overall size of any increase in the deficit.

Trump has also said he wants more investment in public
infrastructure. That is something the US desperately needs, but
remember that Trump will usher in an era of crony capitalism and
politics like never before. The infrastructure that you might get
could be far from the infrastructure the US actually needs, and
instead may be whatever buys votes or other kinds of deals that help
a Trump administration. Now if that infrastructure was produced
entirely by those who otherwise would be out of the workforce but
would like the jobs involved, then aggregate welfare would still
increase: it is Keynes’s famous digging holes example. But in
practice that seems unlikely to be completely or even mainly true,
and so these white elephants may in practice crowd out better
projects. In that case US citizens would not be better off in the
short term as a result of this fiscal stimulus, even if GDP did rise.
And the stimulus would not pay for itself, so once again other people
should worry about the government’s intertemporal budget
constraint.

If the economics of Reactionary Keynesian is bad, I think the
politics is even worse. Quite simply, by achieving very little beyond
redistributing to the rich and unworthy, it gives Keynesian policy a
bad name. But we can avoid that, when we can, by not calling every
increase in the deficit a stimulus. And by saying tax cuts for the
rich paid for by borrowing are really tax increases for everyone
else.

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